Investors may have felt a kinship with Olympic downhill skiers in early February—a big and fast drop at the top of the course and a hold-your-breath ride thereafter. Volatility eased somewhat and the market regained its edge by month-end, but it did not make it through all the gates unscathed.

Experts tossed around several theories about what caused stocks to correct (i.e., a decline of more than 10% from the recent peak). Consensus seemed to settle on inflation fears exacerbated by a strong jobs report, concerns that the Federal Reserve would raise interest rates more aggressively than forecast, Treasury yields rising, and expensive valuations. Traders betting that volatility would remain low likely had a say in the slide too. The Cboe Volatility Index® (VIX®) hit levels not seen since the financial crisis.

Many analysts chalked up the sell-off as healthy, in the “what goes up must (at some point) come down” sense. Perhaps making it easier to digest was the economy continuing to pick up speed. Count the Fed as positive on how it’s tracking. Among others, new Fed Chairman Jerome Powell highlighted a robust job market and accelerating wage growth as tailwinds in the semiannual monetary policy report to the House Financial Services Committee.1

The market seemed to think Powell’s testimony leaned hawkish. Stocks sold off and bonds slid as investors weighed whether he opened the door for a fourth interest rate hike this year, one more than previously forecast.2 And with that a capper on a topsy-turvy month, let’s take a look at what else had the market’s attention.

Source: Cboe

Domestic equities

Without question, some of the swings in the major indexes were eye-popping. The Dow Jones Industrial Average lost 666 points, or 2.5%, on Friday, February 2. The following week was even rougher as the Dow lost 4.2% and 4.6% in two separate routs of more than 1,000 points.

However, stocks got back up and by the end of the month pared their losses, though not by enough to bring them back into positive territory. On a total return basis, the S&P 500® had its monthly winning streak snapped at a rather remarkable 15 months in a row, the longest in its history; the benchmark recorded its first down month since October 2016.

From a sector standpoint, there was really nowhere to hide. According to Morningstar Direct, Technology (+0.1%) was the only sector to post a positive total return, and even that was by the slimmest of margins. Notably, tech increased its weighting in the S&P to more than 25% in February, a milestone not seen since 2000. Financials (-2.78%) followed, perhaps buffeted by the prospects of banks benefitting from Fed interest rate action. On the other side, energy (-10.82%) struggled the most, likely pressured by falling oil prices, followed by consumer staples (-7.76%).

Source: FactSet

International equities

Foreign equities felt the pain too. All told, some estimated the sell-off across global markets at $6 trillion.3 But similar to stocks in the US, foreign equities eventually found some footing, likely backed by the still-intact global growth story. Foreign currency strength against a weaker dollar may have been a factor as well.

It wasn’t enough to erase all of the losses, but international’s attractiveness did not appear to wane, as fund flows remained strong. 4 For the month, emerging markets outperformed their developed market counterparts. By region, index provider MSCI’s EM Latin America and Europe, the Middle East, and Africa (EMEA) indexes, which captures large- and mid-cap representation across select EM countries, outperformed their counterparts in emerging Asia

In Asia, disappointing economic data and interest-rate talk seemed to weigh on the market at month-end. On the political front, investors found pros and cons with China’s plan to eliminate presidential term limits. The move would allow Xi Jinping to extend his term beyond 2023. Some analysts viewed such political stability as positive for Chinese assets. But they also noted the risk of policy missteps.5

Source: FactSet

Fixed income

The bond market fixated on the 10-year Treasury yield’s upward climb and its flirtation with 3%. While low historically, the market views 3% as an important psychological level—the 10-year is a benchmark that helps set the price for many (if not all) assets. The more attractive the yields are on safer assets, like government bonds, the less attractive investors may find equities.

At one point the 10-year yield went as high as 2.95% (and in the process wiped away a 300-point intraday surge in the Dow). For the month, it settled at 2.90%, up from 2.41% at the start of the year, but not before one last late jolt from Powell’s testimony.6

By segment, everything was negative. As would be expected in a rising rate environment, short-term Treasuries outperformed their longer-term counterparts. Treasuries with 1–3 year maturities (-0.04%) was the best performing area, followed by 3–5 year Treasuries (-0.26%). Treasuries with maturities 10 years and longer (-3.00%) performed the worst.

Source: US Department of the Treasury

The bottom line

It was never a question of if volatility would kick up again—it was when. Prior to February, the largest peak-to-trough decline in the S&P for nearly two years was a mere 3%.7 That’s not normal. What are normal are periodic pullbacks and corrections. And since they’re normal, they don’t have to be viewed solely in a negative light.

Rather than fearing downturns, investors may want to consider embracing the opportunities they present. As the stage appears set for volatility to change the scope of this bull market in 2018, now may be a good time to:

Review risk tolerance. Regularly defining how much risk your portfolio can absorb can help keep market swings in perspective.

Diversify. A broad mix of stocks including foreign equities and bonds, across the maturity spectrum, can help guide investors through volatility. The international story remains intact amid synchronized global growth, and the value offered by emerging market stocks may be worth a look.

Rebalance. One way to cope with volatility is to rebalance back to target allocation. Disciplined rebalancing helps investors buy low and sell high by trimming winning asset classes and redeploying to those that have underperformed.

February was a case study in market turbulence—it can be a tough run out there at times. But even among the rough patches, investors can find opportunities that help keep their portfolios upright and on track to meet their goals.

As always, thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

Additional contributor:

Andrew Cohen, CFA

Director, Investment Strategy

E*TRADE Capital Management, LLC

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) and Certified Investment Management Analyst (CIMA) designations. He is a graduate of Middlebury College with a degree in economics.

Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.

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Index Definitions:

Dow Jones Industrial Average: Computed by summing the prices of the stocks of 30 companies and then dividing that total by an adjusted value—one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities.

Barclays Capital U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

Dow UBS Commodity Index: The DJ-UBSCI is composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as "rolling" a futures position. The DJ-UBSCI is composed of commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME).

MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

The Russell 3000 Growth Index measures the performance of the broad growth segment of the U.S. equity universe. It includes those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 3000 Growth Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad growth market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 3000 Value Index measures the performance of the broad value segment of the U.S. equity universe. It includes those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 3000 Value Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad value market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

The Nasdaq Composite Index is a broad-based index that includes all domestic and international-based common stocks listed on the Nasdaq Stock Market.

The VIX®is the ticker symbol for Chicago Board Options Exchange (CBOE) Volatility Index®. The index, also called the fear index, is calculated by CBOE and generally measures expected volatility of the U.S. market in the next 30 days. The higher the number, the more bearish the market is in general. The VIX is used to calculate the put/call ratio.